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To Buy or To Lease (published in November of 2009 in the SB News Press)

Buying or leasing a car has always been a complicated subject. As a business owner, there are certainly tax implications and opportunities that should be considered when choosing between the two.

Although the government has concluding its “cash-for-clunkers” program, there are still plenty of good reasons to buy or lease a new car today. First, this is a great time to buy or lease a car, since manufacturers are hurting for business, and are offering all kinds of deals, incentives, rebates, discounts, etc. Second, rates are incredibly low, so those with good credit are likely to receive attractive lease or purchase rates for loans. Finally, there are several new, exciting models that have been released, or that will be hitting the market shortly, so the choices are numerous.

Basic Differences

If you buy the car, you own it, and get to keep it forever (if you like), whereas if you lease, you do not own the vehicle, and must return it at the end of the lease term, unless you re-lease it, or purchase the vehicle. Whether you buy or lease, you pay taxes, registration and other fees up front. With a purchase (if you finance it), you will pay a down-payment, which usually includes the first month’s payment, while with the lease, you will pay a refundable deposit and the first month’s lease payment.

The taxes, registration, and other fees can be folded into the payments. When you buy, the payments are almost always higher than lease payments would be for the same vehicle. This is because you are paying for the entire purchase price plus interest and any taxes, fees, etc, while with the lease, you are only paying for the depreciation of the vehicle plus interest, and any taxes, fees, etc. (The Economic Stimulus package signed into law on February 17, 2009 allows you to deduct new vehicle sales taxes on your federal income tax return, even if you don’t itemize, for individuals who make $125,000 or less, or joint filers making $250,000 or less. This deduction is only good through the end of this calendar year, (unless it is extended). Vehicles priced under $49,500 and weighing less than 8,500 pounds qualify for the full deduction, and the first $49,500 can be deducted on any vehicle above that price.)

One important fact to consider regarding depreciation is that cars do not depreciate at an equal rate. In other words, the value of the vehicle does not decline by the same dollar amount each month or each year. Rather, the largest amount of depreciation occurs in the first few years, and then depreciation begins to taper-off as the vehicle gets older. So, the implications are that, although when you lease, you are paying for those first years of depreciation, you also experience the majority of depreciation in the first few years as a buyer. This means that, as a buyer, you will own the vehicle once the loan has been fully paid, but the value remaining in the vehicle will be substantially below the original purchase price, even if the vehicle is only four or five years old.

Another fact when comparing buying and leasing is that, when you buy, you pay sales tax on the full purchase amount, whereas when you lease, you only pay sales tax on the down-payment up front. You also will pay taxes with each lease payment, but only on the amount of the payment. Since you will never pay anywhere close to the original purchase price of the car with a lease, you will pay far less in sales taxes when leasing versus buying.

A purchased vehicle, even if financed, can be sold at any time, while a lease involves a contract that could be as costly to terminate as simply paying-out the term of the lease, due to termination charges. If you decide you want a different vehicle, you will have to sell or trade-in a purchased car, while at the end of the lease term, you simply pay any outstanding charges, and walk away. Mileage matters with the lease, since the lease payment you choose up front is directly calculated, based on the number of miles you plan to drive. Also, if you go over the allotted annual miles stated in your lease contract, you will incur additional charges at the end of the lease term, usually on a cents-per-mile basis. When you own a vehicle, the mileage only matters if and when you decide to sell it—more miles will typically reduce the resale value of any vehicle.

If you own your car, excessive wear and tear will reduce resale value as well, but will not cost you anything out of pocket (unless the vehicle breaks-down), whereas with a lease, you may be required to pay additional fees for excessive wear and tear, which can be quite costly.

According to Duane Sanders, General Manager of Santa Barbara Auto Group, which offers seven brands—Audi, BMW, Mercedes, Porsche, Jaguar, Land Rover, Smart—virtually all auto manufacturers are offering special incentives between now and the end of the year, trying to close-out remaining 2009 inventory and also move 2010 models. Porsche has the new Panamera that offers exciting, sports car performance with the convenience of a four-door sedan. (There are no deals being offered on the Panamera, yet). Sanders advises that those who are looking to purchase now should have confidence that good prices and other attractive incentives are already available today, so there is no need to wait. And, selection is better today, so those who wait may have fewer models and options to choose from.

Graham Chevrolet Cadillac Saab also has some great incentives and has the new Camaro, which is one of my favorite new models. Chevrolet is also offering a 60 day satisfaction guarantee—if you buy your Chevy by November 30, 2009, you can return it within 30 to 60 days with less than 4,000 miles on it. They also offer military and college discounts.

According to Andrew Gardner of Hocking Denton Palmquist, A leased automobile is considered to be rented equipment. Therefore, the IRS allows for the taxpayer to deduct all lease payments. If the leased automobile has a fair market value at the time that it is leased of greater than $18,500, the IRS considers the automobile to be a “luxury automobile,” requiring an inclusion amount calculation to reduce the deduction for lease payments, with that amount starting at $20 for an $18,500 vehicle. In additional to the lease payments, the taxpayer is entitled to any other expenses incurred to operate the vehicle including gasoline, repairs, maintenance, and registration.

If the automobile is purchased, the taxpayer has two choices:

1.) The owner can deduct the expenses for both depreciation and all other expenses incurred to operate the vehicle, with the depreciation calculated using the five year depreciation and limited to $2,960 in the first year, $4,800 in the second year, $2,850 in the third year, and $1,775 in each subsequent year.

2.) The owner can deduct an amount based on their annual mileage. The owner would take the number of miles driven in the year and multiply it by the IRS standard mileage rate to calculate the total deduction. The rate is meant to include all expenses and depreciation, so no other expenses are allowed to be deducted. In 2009, the rate is 58.5 cents per mile.

It is important to note that the taxpayer can choose either the actual expense or standard mileage rate to figure the deduction for automobile expenses, so it is wise to pick the method that will lead to the largest deduction. The method that is selected in the year the automobile is purchased is the required method for the remaining use of the car.

With the current economic situation, it is difficult to spend money on just about anything. But, if you are in the market for a car, this is a great time to get a great deal. Each of us must weigh our options and decide whether it would be better to buy or to lease our new vehicle. Our local dealers can certainly help answer any questions and provide lots of alternative financing options as well. One thing is certain, dealers are highly motivated to sell cars, and will welcome your inquiries.

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